CHAPTER 3 - THE CASE OF AZERBAIJAN
3.8 Problems with the present system
3.8.1 Inconsistent Regulations
From the perspective of municipalities, the legal and regulatory framework creates serious impediments to their proper revenue mobilization. Efficient mobilization of revenues is limited by contradictory and overlapping regulations.
One of the biggest and most important inconsistencies of regulation is concerned with the uclear division of authorities by the legislation between local governments and regional branches of state administration (local excoms): The current Azeri legislation provides vague description of intergovernmental relations between local governments and local excoms. In principle, municipalities and local excoms should carry out their activities autonomously.
However, there is no explicit division of authority in the current legislation. The topic is not even touched upon in the Constitution. The resulting ambiguity, therefore, needs clarifying.
The opposing interests of municipalities and local state bodies will inevitably cause a dissention in the absence of a precise clarification of authority. In the legislation, many issues referred to municipal competence are also referred to the discretion of the local excoms. In some cases, local excoms even continue to manage those areas delegated to municipal authority. One example can show the seriousness of the concern: According to the law, municipalities are entitled to advertisement revenues in their territories. However, most municipalities in Baku are concerned about the fact that the Baku Advertising and Information Department, which is a subordinate entity to the Baku Executive Committee (Excom), hinders the municipal budget in getting these revenues. Subsequently, more than 50% per cent of municipalities in the capital city can not receive advertisement profits as properly.
The same occurs around local taxes. For instance, in the case of Barda district municipality, although land and property taxes are stipulated to flow to municipalities, the local excom of Barda district imposed some illegal amount on these taxes that has to flow to the regional tax department. So the current legislation does not provide any perfect regulation of the role of local excoms.
3.8.2 Problems with local taxes
As earlier stated, the main problem of local government is the gradually increasing lack of financial resources. At first sight, one can think that subsidiarity principle is almost ensured in the assignment of local taxes. That is, the land and property taxes are at the discretion of local governments. However, even these taxes are difficult to implement in Azerbaijan due to the following reasons; First of all, although the land tax seems to be as an attractive tax source for local government, in practice, the size of tax applied on land is insignificant. In 2005, the land tax was collected to local budget only to the extent of 25.6%.
The low level problem of land tax can be explained in this way: For example, the Law on
Land Reform states that thirty-three percent of common lands should be possessed by municipalities. These cover all lands not privatized or retained by the state and appear in the possession of the reserve fund. The law also stipulates that municipal lands are determined and transferred by the relevant local excoms to local governments. However, as most local government officers of big cities like Baku, Sumgayit and Ganja, say, the state administration bodies do not seem willing to transfer these lands to municipalities, since there are land plots bringing in big profits. In many cases, local excoms have already leased many of these lands for a long-term.
International experience shows that the property tax is very important among the local taxes. In general, the main reasons for handing over the property tax to subnationals are 1) it is possible to localize the taxpayer within the territory of local self-government 2) efficiency costs of using it as a tax base turns out less thanks to its impossibility of being immovable16. However, another problem is related with this second biggest propert tax. The Property tax diminished to 2.3 % in 2005, while it made up 6.6 % in 2002. There are problems with both calculation and collection of property tax, thus being main obstacles in collecting high level tax. Reasons for less property tax are also as follows: there is no concrete registration system of properties owned by local residents; the value of registered properties is incorrectly calculated; the minimal amount of property tax reflects no real economic condition; The property tax is assessed on the basis of its inventory price not on the market price; Local governments are not fully authorized to collect property, as well as, land taxes in the sense that, as mentioned above, municipalities are only authorized to collect these taxes from private persons, not from legal persons or entities. Legal entities have territories, which occupy huge municipal areas and these property taxes which are collected by central tax
authorities flow directly to the state budget. The revenues from property tax thus become limited.
As opposed to 2002 (38.8), internal tax revenues and duties decreased to 25.6 % of the total budget revenues in 2005. In 2004 only 53 % of planned land tax and 57 % of planned property tax was collected. In general, the growth factor of tax revenues through the years 2002- 2005 is shown in percentage in Figure 2 below:
The decreasing trend is also attributed to the fact that the authority to collect this tax has been transferred to municipalities who do not have enough legal competences to collect these taxes. The authorities of municipalities claim for the inclusion of local self-governments into the public administration system. At present, municipalities are not included in the Public Administration system.
Subsoil mining tax appears another income resource for a few municipalities.
However, the natural resources are unequally distributed across jurisdictions and there are construction materials in only 20-25 % of all municipalities’ territories. It implies that not all local governments can benefit from this source for their budgets.
Share of local fees and duties in local budgets also indicates the autonomous local governemtns. However, As is seen from the table, the share of inflows from duties and fees in
32 25
38
48
0 50 100
2002 2003 2004 2005
local budgets does not even account for 1 percent (0.92% in 2003). The small share of fees in the local budgets can also be explained by the fact that the parking fees have recently been taken from municipalities and given to the authority of Local Excoms. Another problem, like in the case of local taxes, is the collection of these fees. Municipalities are unable to collect all fees and taxes.
Furthermore, as Table 1 shows, a great part of revenues are not reproducible, nonrecurring and thus incidental by nature. It means that they are unsustainable over a long run, although they make up a large share of revenues for municipalities both at present and during the past years.
Moreover, the revenue base information is incomplete and collections are low. It should also be added that central government transferred the function of collecting land and property taxes to municipalities in lack of clear and necessary legislative tools. Legal enforcement is practically non-existent. Local governments are not equipped with legislative competences in tax collection. In some cases there is a proposal made by some interviewed local government authorities to pass the administration of all local taxes to centre, claiming that they do not have necessary legal leverages and proper equipment to satisfy all requirements of tax collection. However, this is not a reasonable solution. As it is emphasized in World Bank Report 2000, transfers are almost always necessary, but they should not be so large as to exceed the need for local taxes. Local taxes ensure that subnational governments face, at least to some degree, the political consequences of their spending decisions. And political necessity leads to the need for relying heavily on local taxes.
3.8.3 Local Budget Expenditures
It would further, be better to look through the expenditure-related problems of local budgets, as are shown by the table below for the years 2002 through 2005.
25.8
2.1 3.8 23.4
28.8
2.2 1.2
9.5
0 5 10 15 20 25 30 35
Administrative expenses of local
government
Education costs Healthcare expenses
Establishing and developing of
municipality housing-communal
system
Road construction and development
Payment of municipality debt
Environmental protection costs
Other Expenses
It can be seen from Table 2 (Appendices) that the great part of local government expenditures is dedicated to administrative costs. Their share in total budget expenditures is even higher in several regions. For example, this figure in the Yardymly district is 39.6%, in Lenkaran City – 40.7 %; and in the Zakatala district - 48 %. In the other districts this figure ranges from 30% to 60%. The distribution of expenditures for an average local government is reflected in the pie-chart below:
Figure 3: Structure of local budget expenditure in 2005 (%)
Source: State Statistics Committee 2005. Revenues and Expenditures of Local Self-Governments.
Hence, looking at the decreasing level of receipts and increasing expenditures across the years, it is obvious that local governments are coming subject to weak financial power.
Furthermore, a comparison of local government’s current financial power with their responsibilities as defined in Azerbaijan law indicate that to realize social and economic projects, financial resources are lacking.
3.8.4 Lack of fiscal Choice
Local self governments have legal authority to decide on their budgets. But the fact that the state funds go to the accounts that are easily politically manipulated by the Excoms (Local state administration) limits sub-national autonomy. Yet, it is emphasized that in order
to fully realize the subsidiarity principle in the field of local expenditure assignment, sufficient own fiscal resources and unconditional transfers, which can be appropriately and efficiently adopted by the individual municipalities according to their own needs, should be provided (Frenkel 1986, Hyman 1993). These intermediate levels remain accountable and subordinate to higher levels of government, rather than to the electorate. This subordination has therefore a negative impact on the flow of state funds through these intermediate levels in terms of limiting real autonomy and decision-making power by the lowest levels of government (who are accountable to the electorate). Bird emphasizes objectivity, simplicity and transparency as important elements in designing transfers for the better performance of the system (1999). However, the transfers are not transparent in the sense that due to the greater discretionary authority of this intermediate level, party affiliation or nepotism oftentimes prevails while these funds are distributed to subnationals. All this indicates the deconcentration or even delegation of activities, rather than practical decentralization.
Furthermore, as it was mentioned above, although all municipalities have had property allocated to them, in many cases this property has not yet been distributed, but remains in the hands of the excoms. This parallel system rather than only local governments in managing services causes tension and impedes proper sharing of responsibilities. That is why this parallel decision-making should be maximum reduced or even eliminated.
3.8.5 Problem with the current transfers
Finally, the last reason for increasing lack of financial resources in municipalities is a symbolic state financial aid. For the purpose of fair and effective equalization of municipal budgets, unconditional (subsidies) and conditional grants (subventions), budget loans, etc.
other techniques are employed. The budget law says that if local governments are unable to fulfill their responsibilities at the expense of their own financial resources, they should get
state financial aids. According to the budget law, these transfers are allocated in the form of subsidies and subventions. Nevertheless, the legislation defines neither principle nor criteria for distribution of subsidies and subventions to local municipalities. These state transfers are often spent without conditions – they are not related to any specific expenditure functions.
This makes local government officials less accountable and interested in spending these funds. The amount of subsidies and subventions do not make any significant contribution to the total municipal fiscal capacity and this is likely to be the case in the future. In 2002, 37.5
% of local government’s income was generated from state transfers, while this figure accounted only for 7.8 % in 2005. Local government officers hold that the transfers do not only happen to be insufficient, but also very volatile. According to the Law on the Budget System does notprovide any defence of subnational units with state financial aids, including subsidies. Consequently, when state budget faces financial problems, the amount of state financial aids decreases. In 2002-2004, state official transfers to local budgets were quite irregular and characterized with systematic delays. Although the state financial aid in the amount of AZM 53.000 billion to municipalities was planned in 2002, AZM 24 billion (45 %) was appropriated only. In 2005 the Azerbaijan government decreased the amount of estimated financial aids to municipalities to 7.8% (see: Figure 4 below). That is why, state transfers do not contribute much to the stability of local budgets and causes unpredictability in local budget planning. The same concern also applies to privatization revenues since they are time-limited and sustainability of theses revenues can not be expected. Furthermore, the amount of subsidies is decided by the government and the parliament individually. In other words, municipalities not only lack specific income sources, but also have problems with financial aids allocated from the state budget.
Figure 4: Total share of subsidies and subventions in local budget revenues (%)
In addition, although the law in force envisages full independence of budgets of all levels, the cash-flow from the center to local budget has been accepted as a key principle. It can be inferred that the inclusion of these principles in the law is of formal nature and therefore during distribution of state transfers to municipalities, a lot of manipulations are the case (i.e. a local state administration authority in a region has closer relations with concerned government structures). In 2004, state transfers to municipalities in Akdash district accounted for AZM 149.9 million, while this figure for Mingechevir (a city in Central Azerbaijan) has been in excess of about 50% (AZM 80 million). Similar cases can be observed at Aksu and Yevlah or Lerik and Ismayilly or Agcebedi and Barda.
The role of the respective region in the establishment of the country’s financial power (that is to say the region representing municipalities to receive State grant) is in the limelight not only due to its formality, but also its lack of concreteness. For the country, financial capacity is a broader term, and it is a challenge to assess the real situation for each region under this notion. Most probably the point here is about the role of regions in the establishment of State budget revenues.
Figure 5: Share of the regions in state budget revenues
26.9 8.7 7.8
37.4
0 50 100
2002 2003 2004 2005
Regions 10.95%
Regional municipaliti
es 87%
Capital municipaliti
es 13%
Figure 6: Share of state grants as per capital and regional municipalities
As may be seen in the Pie-chart above for 2005, 89% of budget receipts came from Baku, while the rest (11%) came from regions17. Undoubtedly, if this principle were accepted as an absolute condition, municipalities in Baku would get significant part of the State transfers (at least 50-60%). Nevertheless, only 13 % of the total financial aids were appropriated to these municipalities. As it is shown in the Table (in Appendix), although Lenkaran and Gence paid the same funds to State Budget, the difference between transfers allocated to their municipalities is three times. The same is observed in statistics on Barda and Zagatala or Kurdemir and Bilasuvar.
Briefly, in case of Azerbaijani intergovernmental transfers, it is possible to observe some drawbacks of ad-hoc distribution of transfers, which are suggested by Bahl: such as, non-transparency, political manipulation, uncertainties concerning the amount of funds to be received by local governments, consideration of local governments as a lower priority issue by the central government and therefore a possibility of reducing the amount of transfers, local officials indifference towards spending these funds and less control over their budget due to absence of specific expenditure targets (2000). In short, this ad-hoc approach more resembles a centralizing approach rather than decentralizing.
3.8.6 Administrative Incapability
The issue of administrative capacity is also necessary under local revenue autonomy for revenue collection. The low level of local revenue mobilization in Azerbaijan is also explained—by the weak administration. An absence of political will for enforcement (as was mentioned above), combined with weak administration, can explain a low performance of local revenue mobilization. Accordingly, the issue of improving the territorial foundations of municipalities is also of special importance. A number of municipalities have a very small population. At the same time, the powers given to the municipalities are big. Even in the best conditions, there is little hope that municipalities with such a small population and revenue sources will be able to fulfill their duties. In this situation, the only way out is to reduce the number of municipalities by merging small municipalities.
Finally, under these circumstances, municipalities become very desperate. Most of the law defined local revenues are formal and municipalities do not possess stable tax revenues, property to be privatized or rented or profitably functioning enterprises.
Summary of the basic findings
Based on review of documents and conducted interviews, the findings of the research can be outlined as follows:
Although there are laws regulating financial activities of local self-government bodies, the local financial-economic position appears weak. Since municipalities do not have enough resources, it is impossible to talk about their total independence in solving local issues. Local tax payments and fees continually make up a small part of the overall revenues of municipal budgets and do not cover the expenses of the municipalities in full. The local budget system is characterized by a number of negative aspects. First of all, despite the allocation of some taxes to municipalities, it is difficult to collect them. It requires considerable
organizational-legal efforts to calculate and collect them. The land and property taxes is of special importance for local budgets. That is why the payment of the land tax not only by private individuals, but also by legal entities located on the territory of the municipality would considerably improve the income base of local budgets.
In particular, other critical research findings can be summed up as follows:
• No full allocation of land and property taxes to local government, despite the general agreement among the interviewees of municipalities that they have big potential for more local revenues—from land and property taxes.
• No concrete registration system and incorrect calculation of properties;
• The inefficient tax collection performed by weak local governments
• Low administrative capacity and absence of legal enforcement and the issue of inequity;
• Recently limited local fees;
• No specified rules or formulas for distribution of state transfers, and thus an ad-hoc distribution of subsidies and subventions;
• Poitical manipulation of these state transfers by the regional branches of state administration (local excoms) concerned;
• The overlapping and unclear division of the responsibilities and tasks of local governments and local excoms.
• Problem with the allocation of fiscal powers between local excoms and municipalities;
• Widespread parallel decision-making by local branches of state administration and local governments.
The elimination of the increasingly low fiscal capacity of SNGs and also other noted problems can be achieved via tax-sharing transfers. Let’s have a look at possible outcomes from this instrument.
Application of tax-sharing to Azerbaijan
The application of tax-sharing would first eliminate the basic disincentive of central government in tax collection. There must be some incentives both for the central and local governments in administering and collecting some of the taxes. The current situation has driven the central government indifferent towards the collection of local taxes and other revenues by local jurisdictions, since these revenues go directly to municipal budgets. As a result the collection rates appear very low.
However, the initiative of tax-sharing would improve the situation to a certain extent increasing the material interest of both central and local governments. For example, from the perspective of municipalities, tax-sharing will promote a connection between the economic power of the region and the revenues earned from shared taxes making them more interested in ensuring local economic development. That is, if the tax-sharing is properly designed and municipalities achieve some discretion in tax collection, it will not be so much time and work consuming to think about particular incentive components to stimulate additional local tax effort. Local governments will themselves be more tempted to be involved in new economic projects (creating new jobs, providing relevant conditions for medium and small enterprises).
In a word, they will treat their actions in a more creative way for their revenues to increase.
From the viewpoint of proper fiscal planning, most of the interviewed local government councillars in general supported the idea of distributing general purpose transfers from the total pool in a stable manner (e.g. as a share of central taxes). In this regard, the